Re: Hulbert

Mark Hulbert wrote an interesting piece in Barron's about a week ago.

He notes that the 39 week moving average on the DJIA underperforms the buy and hold strategy since 1990. I wasn't quite sure why he used 39week instead of 40 week or 10 month or 200 day. But it's interesting how right he is.

I looked at weekly returns (using his 39 week, which is close enough to 40 week, but the data also does not include dividends) and I also looked at monthly returns. I then used rolling periods of close to 19 years (from 1990 to now) to check how average returns and Sharpe ratios looked. On weekly data, buy and hold average returns outperform the TAA strategy in only 28.8% of weeks, but Sharpe ratios are also higher in TAA than buy and hold in 76.6% of weeks. The general story is that in the early years of the strategy (until 1980), 19 year ahead arithmetic returns and Sharpe ratios are greater for the TAA strategy than for the buy and hold. After 1980, not 1990, things begin to reverse.

Looking at monthly results, average returns are greater in 46% of TAA 19 year(ish) rolling periods than buy and hold as well as 64% in the case for Sharpe Ratios. Monthly also pushes the reversal period back further, to 1974. I also looked at rolling 5 year periods for the monthly data. In 46.8% of rolling periods, the TAA outperforms the buy and hold on Sharpe Ratio, 40% for returns.

I freely admit that the 200 day strategy is not the most profitable and won't even outperform the buy and hold. However, it's key benefit (beyond simplicity that anyone can understand) is that it reduces risk. If you looked just since 1990, the monthly return on the 10 month DJIA strategy (ex dividends) is 5.75% with 10.8 stdev where the buy and hold is 6.5% with 14.5 stdev. Using a 4% risk-free rate, the buy and hold has a Sharpe of .17 while the TAA is .16. However, when you look at geometric returns, the TAA return declines to 5.3% while the b&h falls to 5.5% so that the TAA nudges out the b&h on a Sharpe ratio basis.

Overall, this does confirm what Thornton is saying when he notes that it underperforms recently. However, it's not necessarily as simple as he makes it. Yes, it underperformed recently, but on a risk-adjusted basis it doesn't. The 200day MA still provides a useful indication of when major markets trends have begun or end. They aren't great indicators for short-term traders, but if Grandma paid a bit more attention, then she would be able to reduce some risk.

Though it is obvious to me, I should also note that the 200 day average on just DJIA is not, by itself, what advocates of these TAA systems would use. It is TAA b/c you look at multiple asset classes that should perform well as others do not.

So as an additional treat, I looked at the 10 month TAA strategy using weights of 60/40 on stocks and bonds as represented by both the S&P500 and the DJIA (including dividends) since 1950. The TAA strategy is applied to both stocks and bonds. For reference, the S&P500 TAA strategy performs the best, with a Sharpe of .52, followed by .44 for the TAA DJIA, lastly the buy and holds were the weakest at about .39 each. Since 1990, both the DJIA and the TAA DJIA strategies including dividends and a 60/40 allocation have been roughly the same (Sharpes ~.56). However, the S&P500 TAA strategy has a Sharpe of .72 while the S&P500 version of the 60/40 is only .47. Over the whole period, using the roughly 19 year rolling average methodology from above, the buy and hold strategies outperform the TAA is roughly 72% of the months, but the TAA strategy has a higher Sharpe ratio in 72% of months as well.

So in general, the TAA strategy will likely reduce your returns. Know that when using it. However, it will also improve your risk adjusted returns, but reducing the volatility of your strategy. It also makes most sense to use the TAA strategy on a proper asset allocation strategy and not just looking at it as market timing one index. There is still value at looking at long-term trends when it comes to investing.